1. Importance of the CAPM:
An Empirical Testing Of the
Capital Asset Pricing Model
ECON 3700: Econometrics
April 28th, 2016
Ryan J. Emmons, Luis F. Carreras, Luke Lander

2. History and Origin of the CAPM…
• Founded by four economists in the 1960’s…
• John Linter (1916 -983)
• Jan Mossin (1936 – 1987)
• William Sharpe (1934 – Present)
• Jack Treynor (1930 – Present)
• Soon evolved to become the Capital Asset Pricing Model
(CAPM)

3. Practicality of the CAPM
• Investment management and portfolio decisions
• Corporate finance
• Aids in assessing the critical factor of asset prices
• Risk/Reward slope depends on the investor’s aversion
attitude (graph on following slide)

4. Risk and Return Trade-off

5. The Question…
How does a specific change in stock price effect the excess returns (+,-) and
how do the changes in the market’s excess returns influence a particular
stock’s price.
• Importance of how the market is doing compared to ones portfolio
• How a particular stock’s price moves up or down with the market
• This data can show us the information one needs to asses diversification of
a portfolio so that the investor is at an optimal point on the Security
market line of the risk and return trade-off matrix.

6. Methodology
• We chose our data using historical prices from Yahoo.com/finance for 5
Blue chip stocks trading on the NYSE. Then for our market benchmark
we chose the S+P500 index to be a broad representation of the market.
Return for stock Return for Market
Rit = 𝑙𝑛
𝑃𝑡
𝑃𝑡−1
Rmt = 𝑙𝑛
𝑃𝑡
𝑃𝑡−1
Rit= Return on share Rmt = Return on market
Pt= Current price of share Pt= Current Price level of index
Pt-1= Previous adjusted closing price of share Pt-1= Previous adjusted closing
Rf = Fred.org Data already given for daily return percentages.

7. Methodology Continued
• Derivation of Excess Return...
• Alpha and Beta parameters
• Alpha – intercept of the security market line in the risk and return trade-off
matrix
• Beta – parameter on the market premium that affects the excess return of the
stocks
• We then took the excess return from the five chosen stocks and regressed them
against the excess return on the market

8. Amazon Apple GE GM Wal - Mart
Standard Deviation of
Return, σri
.019549 .016386 .01145 .015284 .010126
Excess Return
E[Ri-Rf]
-.00176 -.00095 -.00111 -.00078 -.00041
Sharpe Ratio (%) -9.003 -5.798 -9.694 -5.103 -4.049
Alpha (α) -.0006
(.000620)
-0000975
(.000536)
-0.0002
(0.000303)
0.000282
(.000446)
0.000173
(.000323)
Beta (β) 1.234157***
(0.08)
.925698***
(0.07)
0.991704***
(0.04)
1.156032***
(0.05)
0.636344***
(0.05)
R2 (%) 25.8889 20.8330 48.6147 37.1736 25.4908
F-Stat 260.9463 196.5747 706.7233 441.9908 255.5614
QUANTITATIVE REGRESSIONAL ANALYSES RESULTS

9. Conclusion
• The CAPM is considered to be the backbone in modern price theory
of financial markets. In the last couple of decades the CAPM has
evolved to include other variables that can help explain portfolio
diversification.
• In theory, it will enable the user to create a much better and more
efficient portfolio
• Despite the limitations and expansibilities, the underlying feasibility
of the model renders itself extremely useful.

10. Work Cited
• Fama, E. (1968). Risk, Return, and Equilibrium: Some Clarifying Comments.
Journal of Finance, 23, p. 29-40
• French, C.W. (2003). The Treynor Capital Asset Pricing Model. Journal of
Investment Management, l (2), p.60-72
• Loth, Richard, "5 Ways To Measure Mutual Fund Risk" Investopedia
•
• Sullivan, E. (2006). A Brief History of the Capital Asset Pricing Model. APUBEF
Proceedings, p. 207-210
• Sharpe, William F. (1994). "The Sharpe Ratio". The Journal of Portfolio
Management 21 (1): 49–58. doi:10.3905/jpm.1994.409501.
• http://www.mcapitalmgt.com/portfolio-investments--risk-management.html
• http://www.investopedia.com/terms/c/capm.asp